Joining the dots on tax

Allister Heath, over at CityAM, the free daily newspaper with a strong financial twist, seems at times to be about the only journalist in London making a robust case for free market capitalism, limited government and low taxes. Given how such a message is almost deemed off limits these days in the Conservative Party, and even City types seem shy about doing so, Allister’s editorials are a rare blast of good sense. He’s on good form today with this:

“Economics is not always intuitive – and that is what makes it such a fascinating and important discipline. Take what economists call “incidence” – the study of who actually bears the burden of a particular tax. It is obvious enough that employees pay income tax. But it is much harder to actually work out who really ends up paying for other taxes; voters are often fooled into thinking that somebody else, usually big business, is being hit by higher taxes while in fact it is them who are picking up the tab, albeit in a way that is impossible to detect.”

Exactly. With a lot of economic arguments, such as law of comparative advantage, the insight is not immediately obvious. That is why, for example, protectionist politicians can win votes by claiming that those evil foreigners are “taking our jobs” – it takes a bit of understanding to see the fallacy in this. And the tax incidence issue that is highlighted here is a good one. There is not just a tax incidence effect where a tax on a sector, such as banks, hits everyone. There is also regulatory incidence too. I don’t know exact numbers, but all the various health, safety, equality, and other rules that are imposed on firms add greatly to the total cost of buying a product. Consider how much of the regulatory burden, for example, translates into the actual price you pay for a car, fridge, or even step-ladder.

So the Tories, in their bid for power, want to impose a tax on banks, and imagine that most voters will cheer and say, “good on yer iDave, give the banks a hard time!” and then fail to join the dots when they wonder why the interest on their accounts is so poor, or why it seems a bit harder to get a loan these days or why buying foreign exchange appears to be a rip-off.

April 12th, 2010 |

18 comments to Joining the dots on tax

He’s right about tax incidence in this case, but apart from that he lives in a topsy turvy world where VAT is a tax on ‘consumption’ (it’s not – it’s a tax on gross profits i.e. wealth creation) and Vince Cable’s largely token Mansion Tax is an ‘attack on wealth’ (it’s not, it would be a modest tax on the occupation, i.e. ‘consumption’ of the most desirable areas of the country).

I can understand his support for VAT, because he is basically a shill for the banks, who are largely VAT-exempt, and because VAT acts as a barrier to entry for new businesses…

The freesheet market in London is heavily contested and it appears there is only room for about three of them – so a tax on NET profits would, in relative terms, bear most heavily on incumbents who are profitable and most lightly on new entrants, whereas a tax on turnover or GROSS profits bears, in relative terms, most heavily on new entrants.

There are two things that speak against taxes: for once, they are always a transfer from productive parts of an economy to an unproductive part. Any one currency unit spent unwisely is already a waste. Why billions should be exempt from that criticism is hard to fathom. Secondly, as pointed out above, there is no ay at all to determine where the tax burden comes to stop and roost. This depends on economic factors such as price elasticity etc. and these change daily. So, as in medicine, if the dosage cannot be determined well then one rather abstains from a drug rather than calling it a “panacea” to revive the economy.

Mark, it does not surprise me in the least
that you support taxes on highly valuable
houses! The description of such a tax as “modest”
is almost comical. The tax is a wealth tax and as such
should be seen as part of a redistributionist, egalitarian agenda. I thought you were a Conservative, Mark. Hmmm.

As for VAT, taxes ultimately are borne
by us all in some form or other.

As for whether Allister Heath is a “shill” for the
banks, well, he is a long standing defender
of capitalism so it is hardly odd that he defends
banks from vote-grubbing politicians.

By the way saying that VAT is a sales tax (a tax on consuption) does NOT mean I would support any increase in VAT – in fact I do not support any increase.

Indeed way back in May 1979 (when I was not yet even 14 years old) I opposed to increase of VAT from 8% to 15% on the grounds that any reduction of income tax should have been financed by a reduction in GOVERNMENT SPENDING (it is often forgotten that Chancellor Howe pushed into effect a big INCREASE in the size of govenment after 1979 – quite the opposite of the myth of the Thatcher years).

Anyway is opposing VAT increases since I was still 13 years of age (right to the present day) enough evidence that I am not a shrill for the banks?

Of course Mr Heath may support a VAT increase (even from its present rate of 17.5%), but that should be showed.

By the way – the “mansion tax” is absurd, but then what does one expect from a man (“Vince” Cable) who called any opposition from business people to the Pay Roll Jobs Tax (“national insurance”) “revolting”.

Cameron and co are bad (really bad) – but Mr Cable is even worse.

A man who is so deluded that he thinks that increasing the top rate of income tax (which is already 50%) will bring in more revenue over a period of years – rather than less revenue.

Almost needless to say, the increase from 40% to 50% will mean that the top rate of income tax will bring in LESS revenue over the next few years.

“But at least the Lib Dems would not have bailed out the banks” – actually they would (Vincent and “Nick” have admitted that) they would just have de facto nationalized them as well – by telling them who to lend money to.

There is a strong element of support for such a Nazi style policy in both the Labour and Conservative party leadership also.

While I’d agree with the tax incidence analysis, JP, I think your analysis of the regulatory incidence is incomplete. You’ve accounted for the compliance costs, but (to my eye, at least) have failed to account for the competitive advantage to established vendors resulting from the barriers that such regulations present to new to market entrants.

The other rob, of course, I should have mentioned that aspect of regulation, but I take it as read from most of the commentators here that if you artificially raise the cost of X, then that tends to work in the interests of larger, established firms.

I am still astonished by Mark’s comments on VAT. Are you seriously telling us that a tax that is added to the price of goods and services (albeit with significant exemptions) does not represent a tax on consumption?
If the cost to me of buying something is inflated by 17.5 per cent due to VAT and I cannot claim this back for any reason, that is a tax on my consumption, surely.

Johnathan, I’m not pretending to speak for Mark Wadsworth, of course, and I could be well off base, but I can see how some may conclude that VAT is a tax on profit. If the price of a good (cost of manufacture at maximum efficiency + profit + tax) is uncompetitive, it can only be reduced by taking less profit; thus VAT is a tax on profit.

Ian B, I am sure it could be regarded as a tax on profits, in that the business would no doubt prefer that no such VAT existed in the first place. But it clearly does affect consumption, which after all is why VAT is typically not imposed on things like food and clothes.

I would support Mark or anyone who wants to lower, or better still, scrap VAT or indeed other taxes. There is no such thing as a good tax, only differing versions of bad ones.

Whether you want to characterize a VAT as a tax on “consumption” or “profits” is essentially irrelevant. It’s the incidence of the tax which matters, as was pointed out in JP’s original post, and the essential problem with any tax on business is that its incidence can never be known with certainty. In other words, one can never know who will actually bear the burden of the tax. This is because the economics will vary depending upon the industry, the specific product, the local economy, and a host of other factors. In the end, the tax may reduce the profits of the owners, it may reduce the wages of the workers, or it may increase the prices to the customers; in fact, it may do all of those things in proportions which vary among industries and over time.

I wrote a lengthy paper on the incidence of the corporate income tax many years ago in law school. The details don’t really matter, but what is important to remember is that businesses do not pay taxes; only human beings do. Sooner or later, every business tax comes out of the pocket of a living person. The only reason for business taxes (income, VAT, gross receipts, etc.) is that they are “stealth” taxes, largely disguised from the ignorant public. That, of course, is why politicians love them so much.

Those who can leave are already making preparation, some of us left last year. This is not just about a political crisis, this is a crisis of confidence that cuts across the entire UK population.

Those on welfare, central and local government, QUANGO’s and agencies who are dependent upon the government tit for their livelihoods will vote Labour. This is the client state and that is why they are paid by Labour – to keep them in power.

The current attitude of ‘Not in front of the children’ has to end, but as the Tories showed at the end of 2009 if you even hint at the truth (i.e. new age of austerity approaching) the electorate sticks their fingers in their ears and pretends they are not listening.

To paraphrase the add from 1970’s Seattle during the Boeing slump “Will the last person leave the UK please turn out the lights”.

Oh, by the way, the “mansion tax” would only be a tax “on consumption” if it was a tax on BUYING an expensive house. But it is actually a tax on OWNING an expensive house – so it is indeed a wealth tax.

A “wealth tax” is a tax on your wealth (such as the “mansion tax”).

And a “consumption tax” is a tax when you buy stuff (such as VAT).

Once it would have shocked me to have to explain the above – but now I have come to expect that everything has to be explained.

By the way Laird is correct – all this tax talk ignores the main point.

The main point being (to steal the form of an 18th century line about the power of “the Crown”) “taxation is to high, is increasing, and ought to be reduced”.

As for the banks:

More wonderful FAKE profits from J.P. Morgan.

I could make profits like this also.

Just (for example – there are lots of other scams going on) allow me to borrow money from the Federal Reserve (which the Fed creates out of nothing) at near zero interest rates, and then lend the money to the U.S. Treasury at a higher interest rate.

I used to be against the idea of a VAT, but have come to prefer it to any sort of income tax for privacy reasons. If you cannot kill taxation entirely, then you are a freer society if the taxation is such that private transactions and finances are indeed private. If there were no other taxes and I paid 17.5% anonymously at point of sale, I would say that I lived in a much freer country than if I had to keep 5 years records, figure out my deductions, possibly get audited, have large government computers keeping track of my records, watching my bank transactions and God knows what else.

Sorry, Dale, but if we do get a VAT in the US (and that’s the way the political winds seem to be blowing right now) it will be in addition to the income tax. We’ll have the worst of all worlds. Relax and enjoy it.

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